Are Investors Idiots?

Tyler Durden's picture

Submitted by Bill Bonner of Bonner & Partners (annotated by Acting-Man's Pater Tenebrarum),

Black-and-Blue Crash Alert Flag

Let us  begin the week “on message.” The Diary is about money. Today, we’ll stick to the subject.  Old friend Mark Hulbert has done some research on the likelihood of a crash in the stock market.


tattered flag bb.

Ye olde tattered Crash Alert flag… should it be unfurled again?



Writing in Barron’s, he points out that the risk – or, more properly, the incidence – of crashes, historically, has been very small:

“[…] consider that the 1987 and 1929 crashes were the two worst one-day plunges since the Dow Jones Industrial Average was created in 1896. Given that there have been more than 32,000 trading sessions since then, the judgment of at least this swath of history is that in any given six-month period, there is a 0.79% chance of a daily crash that severe.


And there’s no reason to believe that the frequency of future crashes will be significantly higher. Xavier Gabaix, a finance professor at New York University, has derived a crash-frequency formula that he believes captures a universal trait of all markets, not just equity markets or those in the U.S. According to that formula, the odds of a 12.8% crash in any given six-month period are 0.92%, almost as low as the actual frequency in the U.S. stock market over the last century.


This means that the average investor over the last three decades has believed a severe crash to be more than 24 times more likely than U.S. history would suggest, and that investors currently believe the risks to be 28 times more likely.”

 Whoa! Are investors idiots, or what? Maybe not. Your editor is among those who happily over-estimate the risk of a crash. He expected one in 1998…and again in 1999…and when it came in 2000, he was as surprised as anyone.

Then, prices went up again. And again, he raised the old black-and-blue Crash Alert flag. In 2005… in 2006… in 2007… finally, in 2008, he got what he expected. And now that the market has recovered again, he expects another one.


Investors and Turkeys

Statistically, as Mark points out, the likelihood of a crash coming on any given day is small. But that is a little like telling a turkey not to worry because the likelihood of Thanksgiving is only 1 out of 365.



Really, what are the odds?


Eventually, all turkeys and all investors get whacked. And, generally, the longer a market goes without a correction, the more it needs one. Besides, there is something a little fishy about these numbers.

In the last 20 years, there were the aforementioned  sell-offs in the stock market – one in 2000, heavily concentrated in the Nasdaq and the other across the board in 2008. But people don’t think of investing in terms of avoiding the specific day of crash.

Investors don’t really care if a crash happens on a Wednesday or a Thursday. If they think a crash will happen any time within six months, they usually want to stay out of the market – realizing that they can’t time these sorts of things with any precision. So if we look at it in these terms, there were 40 six-month periods in the last 20 years. And crashes happened in two of them – or one in 20.

If investors truly believed that the odds of a crash were 28 times higher than one in 20, they would have believed that there would be a crash every six months. And they would have been out of stocks all the time.


shoved 2

You don’t want this to happen, even if the chances that it will are fairly small…



It’s Like Russian Roulette

Also, the statistics Mark cites do not really gauge the “risk” of a crash. They speak only to the frequency. Imagine the drunken imbecile who puts a bullet into a revolver, spins the chamber, and puts the gun to his temple.



Statistically speaking, Lady Luck is likely to be on your side in Russian Roulette…but it’s probably still not the best idea to do it.


“There’s only one chance in six that this will kill me,” he says. Statistically, he is right. The odds are in his favor. But what a bad bet! The true measure of risk involves more than just statistical probability. The frequency needs to be multiplied by the gravity in order to get the true picture.
The typical investor is in his 50s. If the next stock crash is followed by a big bounce, like the other two crashes in the last 20 years. He will be glad he paid no attention to our warnings and just kept his money in stocks.
But what if the stock market crash of 2016 is more like the crash of 1929, or the bear market of ’66? He could have to wait 20 years to break even. Or if it is like the crash that happened in Japan in 1990, he’ll still be waiting in 2042.



The Nikkei, monthly since 1987. It’s been a long wait, and the waiting continues…most buy and hold investors who got into the market in the late 80s are only likely to reach breakeven in the afterlife – click to enlarge.

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LawsofPhysics's picture

How long is the average stock actually held, maybe a few microseconds...

what "investors"?

USisCorrupt's picture

Yes !

Anyone not Invested in HARD ASSETS is a FOOL !

StackShinyStuff's picture

Who are these "investors" you speak of?

nuubee's picture

Disney Lemmings, the worst kind of lemming.

asteroids's picture

There ain't no such thing as "investors" in a market that is rigged by the FED and the "boyz". It isn't even a casino. No, this market is a fleecing machine. Stay the fuck away.

PT's picture

Compulsory Retirement Funds is the lemmings, I mean "investors".  They got no choice.  Oh sure, the Super funds will do their best ... with what they have been given.

PT's picture

Compulsory Superannuation.

2012 was the year that the oldest Baby Boomers started retiring.  I expect them to continue to take more money out of the system.  Some time around 1992 was the year that Australians were forced to pay into Superannuation, whether the returns were available or not.  Whether new companies were being created or not.

Every year a large amount of money enters the system via Compulsory Superannuation and it has to go somewhere.  Net super contributions subtract BB super payouts = amount of money entering the system THAT HAS TO FIND SOMEWHERE TO GO.  I do not know US laws so I do not know US equivalent of this equation.  Isn't there anyone analyzing this ( US or Aust ) ?  This is your most fundamental DUMB money.  It is THE DUMBEST MONEY.  Because a lot of shit can be hidden when someone isn't going to see their money for 40 years or more. 

Assuming Compulsory Superannuation at 5% and zero percent compounding, after 20 years in the workforce there is one dollar of invested money looking for a return for every one dollar being earnt.  Next year there will be an extra five cents looking for a return that isn't there - i.e. $1.05 looking for a return on every dollar earnt.  (yes yes, the $1.05 won't need to see the whole dollar immediately - just a dividend yield ...)  Is anyone out there analyzing this?  Compulsory super wasn't 5%, it changed.  Compounding wasn't zero percent, not for a while, anyway. 

Using the above example, after a 40 year work life (25 - 65, say) one retires with two dollars invested for every dollar they earnt in their last year.  If no dividends are paid, they can draw out 50 cents per dollar earnt for four years before the money runs out.  Or has sales and production increased to the point where they can receive a 50 cent dividend forever?  Still trying to get my head around this whole scenario, hence all the simplifications but isn't there anyone out there who models this properly for a living?  What are the real numbers?  Or do they prefer to keep the results hidden?

nuubee's picture

There's still currently some value to having cash sitting around ready to be used... but I think soon most people will want everything they own to be non-fiat-paper-based.

KnuckleDragger-X's picture

Cash will be useful for a few weeks/months at the end, but yeah, physical anything will rule.......

RattieNomNom's picture

i have truckloads of boxes with hard toffee candy ;P  SRS NOM for years! :D

bada boom's picture

Can't wait to talk to all the relatives on how high the stock market is over the holiday weekend. Things are great.  Buy, Buy, Buy... /s

Seasmoke's picture

Be a Patriot. Sell all your Gold before the Memorial Day Weekend !!!!

christiangustafson's picture

Sorry, bears, but we need One More High.

Short-covering will do it.

wobblie's picture

Unless you have inside information, investing, especially these days, is just glorified gambling.

john_connor's picture

Investors?  LOL.  The "stock market" is controlled by the Fed and top 6 TBTF banks for the benefit of perception of growth.


TradingIsLifeBrah's picture
TradingIsLifeBrah (not verified) May 25, 2016 9:03 AM

I told you they have to raise rates this summer and they will do whatever they want to get it done.  Rate hike, Summer 16.  Trade accordingly.

PT's picture

I like bold predictions.  Now I just have to remember you made it.  If it happens then you have my permission to say, "See PT!  I told you so."  and ref. these comments.

For reference, I do not believe you but I am truly clueless in this regard so my opinion does not matter.  I would appreciate a good explanation for your assertion that rates will rise.  Thanks in advance.

TradingIsLifeBrah's picture
TradingIsLifeBrah (not verified) PT May 25, 2016 1:06 PM

My explanation is simple, they need room to cut when things blow up.  Its clear that the economy is on its last legs but the Fed has little to no ammo to look like they "have things under control".  My long term assumption is that we will be in negative rates like the European/Japan banks but the Fed can't have a push to negative be its first or second rate cut.  They need some additional room so that they can say, look we cut 3 or 4 times and the economy needs more or better yet to cut twice and then do a "big" move (50bps) of dropping negative.  I think we need rates near 75-100 bps by the end of the year if the wheels haven't come off by then.  

I don't believe the Fed controls shit in the economy but they need to keep up the appearance that they do.  If rates remain low, where they do no raises, and everything blows up then they look powerless (the economy blew up while they were trying to hold it up).  If they raise rates and the economy blows up then it appears like they caused it, which means they can fix it.  The economy is horribly broken right now and they know it, it will blow up either way.  They only need to make people believe they have the power to make or break the economy because if not our whole financial system will collapse.  When the common person realizes the Fed has no idea of what they are doing how much faith would those people put in the dollar?  

So my assumption, which I've stated since like Feb when everyone thought there would never be another rate hike, is built on (1) the economy is going to crash soon, the props aren't working anymore (more debt can't fix this) so the Fed needs to maintain the appearance of control (raise rates while the economy crashes and correlation becomes causation to idiot citizens/investors) (2) the Fed knows it will need negative rates in the next downturn, the Fed knows that negative rates as the first or second move will be a non-starter in the US so they need a little bit of room in the positive interest rate region to cut before they eventually go negative.  And yup I know the rationale sounds stupid, which is exactly why I think they will do it, these people are PhD's and (even worst) Economists, they don't operate in a real world, they operate in models that are completely retarded to anyone with a brain.  I could be wrong but news has shifted to the "obviousness" of a rate hike over the last 2 weeks just as I thought it would.  

lasvegaspersona's picture

To view a crash as a random event seems wrong. There are other factors that surely can elevate the odds above .92% in a 6 month period. Put those in you equation (like an underlying monetary problem) and you'll get better information.

PT's picture

Agreed.  Surely there are certain events that can not be ignored that can be used as outer bound limits for a crash.  Pension money entering / leaving the system as I mentioned above would be one indicator.  Interest rates / loan repayments would be another.  Margin calls another.  And when these indicators don't work, follow the bail-out trails.  Who is being screwed?  When do the screwed die out?  When do the screwed fight back?

Perhaps at the end of the day we are simply looking for a particular oligarch to make a mistake?

SgtShaftoe's picture

suppressing volatility also feeds back on the system virtually ensuring a crash, hence the fat tail event.  It's like Russian Roulette but more powder gets added to the cartridge every time the trigger is pulled.  We're not dealing with a pea shooter in this game of Russian Roulette any longer, more like an 80mm artillery piece at the economy's and civility's head. 

Wow72's picture
"Are Investors Idiots?"

Think about it, they trade in worthless digital/paper currency in a rigged FAKE market and get all proud when they WIN MOAR of this valueless shit and they are sad when they lose the valueless shit? INVESTMENT????  THIS BULLSHIT EXISTS IN PEOPLES MINDS???  I think Idiots would be a complement.

Meanwhile we are all controlled by the gods these idiots PRAY TO... KING DOLLAR!


juggalo1's picture

This article seemed to be a lot of paragraphs groping for a point.  Smart investors know that fear of a crash is no reason to stay out of stocks over the long term.  Why don't they illustrate what the damage from a crash does to a portfolio of different asset compositions?  That's what would matter to an investor.

brushhog's picture

I dont agree with the logic in this article. Markets do eventually crash but in the long run, those who have invested conservatively and stayed the course have increased their wealth. Had you invested in some stock indexes for the oast 20 years, you made money, even if you gave up some of those gains in '08 you are still far ahead.

I'm not a stock investor, I dont have the stomach for the ups and downs. However, my dad has been invested in stocks and mutual funds for 30 years. He took a hit to his GAINS in '08 but has since made it back. Over the long run, so far, the stock market has rewarded investors for the past 100 years. I am simply not the kind of guy who can hand a financial advisor my nest egg and then go on about my life without even thinking about it. My dad, for whatever reason, is able to do it and over the long haul he has profited.

RattieNomNom's picture

I said i make long lasting socks! send monies!

affirmed_78's picture

Problem is everyone hates the market now, and many are waiting for the next crash to get in.  I would normally agree with that strategy, because there are always crashes in the market.  And with the central bank experiment we've seen, who knows what might happen.  But when everyone is on the same side of the trade, it isn't going to happen.  The market's job is to inflict maximum pain.  Right now maximum pain is remaining close to the highs while people sit around and wait for a crash. 

ToSoft4Truth's picture

People are desperate.


Look at the debt template. 

Spungo's picture

Why does anyone care about crashes? An ideal company is one you never sell.

gregga777's picture

Yes and more to the point they are SUCKERS. The Con Street scam crime gangs are going to steal everything a sucker, or investor, take your pick, gives them.

fritskrach's picture

There is never a reason to believe.

oncemore's picture

Yes, they are idiots.

Iconoclast421's picture

The ratio of stocks making new 52 week highs vs those making new 52 weeks lows is still absurdly high. that ratio needs to come down before you can look for a serious drawdown.

onmail1's picture

Unless the Turkey belongs to

gay house (formerly white house)


;-) btw its not the bird


& nobody wants to eat a DOG

(unless u r a chinese)

HisUnholinessObamma to Michelle :

'Have some Chinese today'

Michelle : 'Mee no Chineze rather

u r chinese everyday , becuz

ur boyfriendz make u go down

on a dawg position, I know that hmmm.'